During his second presidential campaign, Donald Trump frequently referred to “tariff” as the most beautiful word in the dictionary. He later demoted it to a mere fourth place, following God, Love, and Religion. People often like to think Trump as a habitual bluffer, yet his tariff talk was not a bluff. Within a week of taking office, Trump threatened both Canada and Mexico with a 25% tariff—a move that was temporarily delayed after the two countries made concessions, at least in posture if not in substance. Chinese were not so lucky; the 10% tariff on their imports has since taken effect (note 1). More recently, Trump also imposed a 25% tariff on all steel and aluminum products (note 2).
The media and economists have responded to Trump’s “trade war” with their typical skepticism and contempt. They have impatiently explained that tariffs are ultimately paid by importers of goods and services, who almost always pass the cost on to consumers. Consequently, tariffs not only reduce trade volume and make everyone poorer, but also tend to exert inflationary pressure on the very economies they are meant to protect. Although I have never taken a macroeconomics course, I am convinced that this is the lesson I would have learned. In ordinary times, choosing between the established wisdom of the economic profession and Trump’s reckless ideas would be a no-brainer. But we no longer live in ordinary times. Today, the reputation of economists is at an all-time low; their credibility has been called into question even by the New York Times, arguably the staunchest defender of expertise and scientific consensus (see note 3 for a recent article).
As I felt the need to conduct my own research on the issue, someone in a WeChat group recommended Trade Wars are Class Wars by Matthew C. Klein and Michael Pettis. The provocative title was tantalizing. Yet, I noticed that neither author is a career economist—in fact, neither appears to have earned a Ph.D. According to Wikipedia, Klein is a novelist and software entrepreneur, while Pettis has taught finance at both Tsinghua University (my alma mater) and Peking University. Although Pettis may still hold a position at Peking University, I could not find any official confirmation.
Do these people really know what they are doing? I was hesitant at first, but I decided to give the book a try, largely because the New York Times article reminded me how often professional economists make mistakes.
The book is an engaging and accessible read—the historical insights into money and finance alone might be worth the time. Crucially, it provides readers with a valuable framework for understanding contemporary economic phenomena. The central argument is that trade wars, although ostensibly fought between nations, are rooted in the conflict between the working class and the elites, regardless of their national origin. In the authors’ own words:
Rising inequality within countries heightens trade conflicts between them. This is ultimately an optimistic argument: we do not believe that the world is destined to endure a zero-sum conflict between nations or economic blocs. Chinese and Germans are not evil, nor do we live in a world where countries can only prosper at others’ expense. The problems of the past few decades do not have their roots in geopolitical conflict or incompatible national characters. Rather, they have been caused by massive transfers of income to the rich and the companies they control.
To a layman like me, the authors’ thesis is compelling, although I feel that, with the benefit of hindsight, their optimism may have been misplaced. In what follows, I shall unpack their argument, focusing on the dynamic between China and the U.S.—the primary contenders in what might be the most consequential trade war of our time.
China
After the major reforms led by Deng Xiaoping, “raising the living standards of the people” through rapid economic growth became the ruling party’s mantra in China. Widely viewed as a cornerstone of the party’s legitimacy, that goal—embodied in the GDP growth rate—has been pursued with relentless rigor and blind enthusiasm ever since.
The current Chinese developmental model took shape in the early 1990s, when millions of peasants migrated to cities to take newly created, better-paid industrial jobs. However, these workers were “systematically underpaid relative to the value of what they produce, which generates a substantial surplus that has been used to fund investments in physical capital.”
Ruthless exploitation of peasants, to be sure, is not new in China. Since 1949, peasants have disproportionately borne the immense human costs of the country’s industrialization, through thick and thin. The difference is that exploitation has become far more effective in the post-reform era. On one hand, modern technology, expertise, foreign capital, and global markets—all made available by rampant globalization—have dramatically boosted productivity. On the other hand, China’s “comparative advantage of lower human rights”—a poignant term coined by Professor Hui Qin—has kept labor costs low by outlawing adversarial labor unions and selectively enforcing the infamous Hukou system, among other policies.
As a result, “workers at nonfinancial corporations in China are paid only 40 percent of the value of what they produce.” To put this figure in perspective, Thomas Pickette (note 4) estimates that labor’s share in national income averages around two-thirds in developed countries—while Klein and Pettis place it at close to 70%, which is not far off.
This high-savings growth model with “Chinese characteristics” worked like magic. It has sustained a growth rate above 7% for several decades, lifted hundreds of millions of people out of poverty, and created an economic miracle that is the envy of the world. The Chinese people have benefited greatly; any one of my friends and relatives in China will tell you that their lives have improved markedly compared to even the 1990s, when virtually no ordinary family could afford an automobile. It is a classic story of capitalism’s rising tide lifting all boats.
However, not all boats were lifted equally.
As Klein and Pettis noted, “the share of Chinese GDP consumed by Chinese households fell by 15 percentage points between the late 1980s and the bottom in 2010.” In 2023, Chinese households consumed 38% of their nation’s GDP, compared to 69% in the US, 55% in Japan, and 51% in Europe (note 5). In other words, despite the newfound prosperity, underconsumption remains severe in China to sustain growth at a breakneck pace. Underconsumption directly results from underpaying workers and is further compounded by China’s regressive tax policies and concentrated income distribution.
Suppressing consumption channels an excessively large share of national income into savings, of which China’s financial policies are eager to take advantage.
Chinese investors have relatively few options to invest their hard-earned savings. For one thing, stringent foreign currency controls make it very difficult for most people to buy overseas assets. Moreover, for reasons few can understand, the stock market in China has been notoriously stagnant and erratic—at the time of writing, the Shanghai Composite Index (SCI) is roughly half of its peak value achieved in 2007, even though China’s GDP has grown fivefold in nominal terms during the same period. For those who entrust their money to government-run banks, deposits tend to lose value quickly because interest rates are set well below the growth rate, ensuring that Chinese manufacturers and real estate developers have access to cheap capital.
Not surprisingly, the real estate sector went viral early on, as it was virtually the only game in the town for those who did not want to be ripped off. This approach worked for a while, sustained by the expectation that real estate prices in China would continue to rise because the party willed it so. When that myth was debunked a few years ago, the last safe haven for Chinese savings was effectively burned to the ground.
In a nutshell, the China miracle has been a mixed bag for its own people. While it has raised the average living standard, it has also created staggering inequalities—and friction between social classes—through years of regressive wealth redistribution. That said, had China kept these problems contained within its borders, the world would happily let it do what it will to its own people. However, as China’s growth model was kept alive on borrowed time, the rest of the world began to feel the pinch.
As an economy grows larger, its growth naturally slows. Simply put, maintaining the same growth rate for a larger economy requires more capital and labor in absolute terms. Moreover, marginal returns on investments diminish as available opportunities become less attractive—after all, a country’s institutions set limits on its ability to absorb investment effectively.
Ideally, the market is best at discovering these limits: when a project cannot yield enough return to break even, it should not be funded. However, in China, growth is determined by the party rather than by the market. Once the overall GDP target is set for the country at the beginning of each year, it is passed down to local governments, where party officials enforce it as if their careers and lives depend on it—and in many cases, they do. This top-down approach creates powerful incentives that distort resource allocations.
As the authors noted, “China’s provincial and municipal governments control most of the credit creation within the banking system, and Chinese banks rarely have to write down loans for projects that cannot service the debt”. Therefore,
the easiest way for officials to hit their targets is to tell the state-run banks to lend to favored companies to invest in as much infrastructure, manufacturing, and real estate as necessary. Whether the investments are worthwhile is irrelevant. All that matters is that the quantity of spending generates enough reported GDP to meet the central government’s objectives.
This might explain, at least partially, the creation and subsequent implosion of the real estate bubble.
Elsewhere, China’s overinvestment has created a huge glut of manufactured goods that cannot be absorbed by its citizens, whose purchasing power was intentionally curtailed. When a country saves more than it consumes and channels those extra savings into domestic manufacturing, it runs a current account surplus from trade in goods (note 6). According to the authors, China accumulated a current account surplus of nearly $1.4 trillion between 1998 and 2008. Yet in 2024 alone, China’s surplus from trade in goods reached nearly $770 billion—about 4% of its GDP or more than 2% of global trade in goods (note 7).
Under ideal conditions, a country cannot maintain a trade surplus indefinitely because the influx of foreign exchange gradually increases the value of its currency, which in turn weakens exports (note 8). However, China circumvented this law by pegging its currency to the dollar, which requires, among other maneuvers, buying incoming foreign currencies with RMB and converting them into dollar reserves. Keeping the RMB artificially below its market value hurts Chinese consumers’ ability to purchase goods, services, and assets from abroad. Consequently, this amounts to yet another wealth “transfer from China’s consumers that subsidized the profits of manufacturing operations in China—including the joint ventures established by American, European, and Japanese companies.”
In theory, manipulating the currency alone would not be sufficient. An artificially weak RMB increases demand for Chinese goods—yet in a nearly fully employed economy, this heightened demand bids up labor costs and causes general price levels to rise. Ultimately, inflation will offset the effort to hold down the RMB’s fundamental value. Fortunately (or unfortunately for Chinese workers), China was able to control inflation by keeping wages well below market value, thereby suppressing consumption.
In summary, China sustained its growth model by underpaying its workers, suppressing consumption, manipulating its currency, and controlling its financial market. This strategy created a massive transfer of wealth from ordinary Chinese people to kleptocrats and oligarchs. At the same time, it generated a huge trade surplus that must be offset by deficits in other countries. Such an imbalance can only be remedied through some combination of (A) increased consumption and (B) declining production outside China. Outcome A seems benevolent at first glance. Isn’t helping others consume more at the expense of Chinese people a good—even altruistic—deed? However, if other nations must borrow to import Chinese goods, their national debt levels will rise. The second outcome is almost always detrimental: at least in the short term, it can lead to factory closures, layoffs, and higher unemployment rates, all of which may trigger political upheavals.
Unsurprisingly, China’s trade surplus is often cited as a culprit behind worsening indebtedness and rising unemployment in other countries. Moreover, there is concern that China’s diminishing returns on domestic investment might now be dragging down global productivity. It is not too far-fetched to assume that the capital forcefully injected into the Chinese economy might be more effectively deployed elsewhere.
For reasons I will now explore, no country harbors this resentment more than the United States.
The United States
The US is deeply in the red. At of now, its national debt stands at over 120% of its GDP—a historical high. The cost of debt service has recently exceeded the defense budget, raising alarms among many elites in light of Ferguson’s law, which states,
Any great power that spends more on debt service than on defense will not stay great for very long.
Additionally, the US has become thoroughly deindustrialized, with much of its once-mighty manufacturing sector decimated by the onslaught of globalization. The result is the desolation of the Rust Belt, a disheartened working class, and, many would argue, the rise of MAGA and Trumpism.
Why did this happen? According to the authors, the US did not really have a choice. Americans had to give up manufacturing jobs and spend money they didn’t have because the rest of the world wanted them to.
For one thing, class wars—as explained earlier—tend to depress domestic spending by concentrating national savings into the hands of the rich and the state. Even in countries that simply wish to increase their foreign reserves for financial resilience, domestic spending decreases as an unintended consequence. Together, these forces have led to a chronic shortfall in global spending and, paradoxically, have made demand for goods and services “the world’s scarcest and most valuable resource.” The excessive savings, taken from consumers who would otherwise put them to good use, are then turned into manufactured goods that must be exported, or into sovereign funds seeking safe assets abroad.
For several reasons, everyone wants American sovereign debt (treasury bonds). First, the US has been the world’s sole superpower for decades. Second, the US dollar is the de facto global reserve currency. Third, the US financial system is large, flexible, open, and, above all, shows genuine respect for investors’ rights. Therefore, foreign savings pour into the US, effectively forcing Americans to absorb the glut of manufacturing capacity at the expense of domestic jobs and incomes. This dynamic has compelled foreign savers to mitigate the impact of job losses on American spending by purchasing dollar-denominated assets, which in turn pushed down interest rates, expanded credit, and facilitated a surge in household borrowing.
Seen from this perspective, what the world has been practicing since the fall of the Berlin Wall is not free trade, but mercantilism in the guise of free trade. Instead of employing tariffs or quotas to discourage imports—as traditional mercantilists would do—modern countries simply hold down the value of their currencies, suppress interest rates, and subsidize exporters, thereby gaining export market share while keeping foreign goods at bay.
In other words, when Trump claims that everyone is taking advantage of America—I cannot believe I am saying this—he might have a point. However, what he may have failed to appreciate is that this arrangement is a direct result of the US-led world order, which was ostensibly designed to serve US interests.
Solutions?
Is there a solution to trade wars—which appear to be a feature, not a bug, of the current world order? Klein and Pettis believe there is.
Because trade wars are driven by class conflicts, one approach might be to persuade elites worldwide—especially in surplus nations like China and Germany—that allowing workers a greater share of national income is in their best interest. By reversing the transfers of wealth from the working class to the rich, there is a hope to resolve this challenge before trade wars escalate out of control. Although this solution sounds inspiring, it is unlikely to succeed. For one, it is far from clear that the ruling party in China could withstand a redistribution of wealth that might require profound political reforms. Moreover, even if China were to transition into a democracy overnight, the inherent flaws of the current world order would remain unresolved. We simply can no longer pretend that the present form of globalization is inherently beneficial or a gold standard for promoting free trade.
This brings me to the second and much darker solution. Fundamentally, America’s commitment to open markets and globalization has turned the country into the dumping ground for the world’s excessive savings. Yet, in a democracy, Americans have every right to put an end to this situation. The re-election of Trump suggests that many Americans have finally made up their mind. Of course, Trump’s tariffs are unlikely to revive the manufacturing sector overnight—if ever. Instead, they signal the forthcoming dissolution of the US-led world order, making an informal declaration that the era of pretense of free trade is over, and that America’s markets and economy will henceforth be selectively open to allies and friends on favorable terms.
Will the second solution lead us to an apocalypse akin to the calamities of the last century? It is still too early to tell. We live in interesting times—may we outlive them.
Marco Nie, Wilmette, IL
February 22, 2025
Notes:
- https://apnews.com/article/trump-tariffs-canada-mexico-colombia-a5ee8bc89b7fbb459ee574c002c90df1.
- https://www.bbc.com/news/articles/c360dz384n5o
- https://www.nytimes.com/2025/01/10/business/economy/economists-politics-trump.html
- See Economics of Inequality by Thomas Pickette.
- https://en.wikipedia.org/wiki/List_of_largest_consumer_markets
- In an open economy, the basic macroeconomic relationship dictates that
Y = I + C + G + X – M, (Eq. 1)
where Y is the total economic output (GDP), I is the investment in capital goods (research and development, equipment etc.), C is household consumption, G is government spending, X is export, and M is imports. Moreover, the saving
S = Y – C – G = (Y-C-T) + (T-G)， (Eq. 2)
where S is national saving, T is taxes, Y-C-T is private saving and T-G is public saving.
If we replace Y-C-G in (1) with S, we obtain
S = I + (X-M). (Eq. 3)
Eq. 3 states that national saving equals investment less net exports.
- https://english.www.gov.cn/archive/statistics/202502/14/content_WS67af350fc6d0868f4e8efa3b.html.
- A few words on a nation’s current account and financial account: The current account tracks the net flow of goods and services; positive net exports result in a current account surplus, whereas negative net exports lead to a current account deficit. The financial account measures the net changes in ownership of financial assets and liabilities. If a country is running a current account deficit, it needs to fund that deficit—often by borrowing from abroad (resulting in an inflow in the financial account) or by drawing down foreign reserves. Conversely, a current account surplus indicates that the country is earning more from abroad than it spends, and this excess is either invested overseas or added to official reserves. Under ideal conditions, a country running a current account deficit would face pressure to depreciate its currency or draw on its reserves, because (i) the need to finance the deficit with foreign exchange weakens the demand for the local currency, and (ii) a depreciated currency boosts exports, providing a natural correction to the trade imbalance. On the other hand, a country running a current account surplus experiences the reverse pressure. The surplus generates an inflow of foreign exchange, which increases the demand for the local currency and tends to drive its appreciation. This appreciation in turn makes the country’s exports relatively more expensive and less competitive, thereby exerting a natural corrective force that reduces the surplus. In theory, therefore, no country can sustain a trade imbalance indefinitely. Yet this is precisely the situation in which China and the United States find themselves.